Absolute Return funds - a useful Portfolio Diversifier

Absolute Return funds are a relatively new concept and we are seeing more funds of this type launched into the investment market, particularly since the Credit Crunch.

Many investors are sceptical about these type of funds, and much of this sceptism is justified, with some funds just not performing as expected. However, if you do your research correctly, there are some good funds available and they should allow you to hopefully achieve positive terms over a year, independent of economic conditions. 

The reason I like these funds is that they can help diversify returns within a portfolio, as they are often uncorrelated with other assets classes. Also consistent absolute positive returns can underpin a portfolio nicely and provide downside protection in falling markets. 

Many of these type of funds don't target large returns, maybe only 5% above cash and it is important to have expectations of returns to help avoid disappointment. Some will also exhibit more volatility than others, so make sure you pick a fund to suit your style. 

Whilst not for everybody I would definitely consider a portion of my portfolio to be allocated to absolute return funds. Insight have good products; Insight UK Market Neutral fund is a very consistent fund and should return around 4% per annum with at current interest rates. Standard Life have their juggernaught fund, GARS, which is £25bn in size! It is a little more volatile but again has exhibited very strong past performance and has a credible strategy and process.

Gold Price Tumbles!

Gold, along with many other commodities have been hit very hard today. As I'm writing this gold has broken through the $1,500oz to stand at $1,498oz, which equates to over 4% loss for the day - a huge downward movement.

There's been a couple of big announcements this week that have contributed to this fall. Today, Goldman Sachs downgraded their long term price view, and we all know the weight with which Goldman can influence markets!

Cyprus has also announced plans to sell gold bullion in order to help them meet their debt burden. This means there is a lot of supply hitting the market, lowering price. Quite why Cyprus announced their intentions to sell before actually selling is a strange one to me, rather than sell and then let the market know! Maybe they have short positions on gold!!

By breaking through resistance lines such as $1,500 it could encourage further selling and the price continue to fall.

Long term holders will of course still be up in their investment in gold, but over the past 2 or so years the gold price has fallen significantly and maybe losing its shine with investors!

With the selling that is currently occuring in the market place it will be interesting to see who the buyers are? Many Central Banks have large gold reserves already and may be deterred from adding to this. Jewellery demand, particularly from China and India can be seasonal so this may not produce the immediate demand required to help stabilize the price.

Mining, Natural Resources and what lies ahead

The mining sector has provided excellent returns to investors over the years, however since the credit crisis it hasn't quite been the same.

Mining and natural resource based companies thrive during times of global economic growth and this was inherent between 2005-2007. Economic growth spurred by a huge amount of infrastructure and housing spending especially from China saw demand rocket for resources such as copper, tin and steel. But as the credit crisis hit, these companies were amongst the biggest fallers. Since then global growth has been anaemic which does not bode well for the natural resource investor.

Inventories of metals have reached 10 month highs recently as a lack of demand in China does not inspire confidence. Furthermore, hard commodities react heavily to geopolitical risks and recent news out of the Eurozone and issues with North Korea does not support future demand.

The main driver it seems for hard commodities these days is China.  A double digit growth rate in the past has meant the vast country has made up a significant proportion of global demand.  Worries over a hard landing were short lived, however investors came to terms with the end of double digit growth.  China now begins to focus on quality growth driven by structural reforms rather than mass export growth.  For the miners, this does not instil any confidence and as such we have seen a fall in prices and outlook for many of the top miners.  

We previously discussed the merits of gold equities, however whilst driven by different demand concerns, these miners continue to be out of favour and some major names have seen their prices almost half since the start of 2013.   

Many companies are looking fairly cheap and it begs the question is it time to buy? Those contrarian investors may be licking their lips.  

Natural resources covers a fairly varied sector and can encompass the commodities themselves (mainly metals) and the associated companies which offer more of a leveraged play. There are a number of funds are out there in this space one of which is JP Morgan's Natural Resources, whilst returns have been poor the last few years, it provides exposure to a number of large mining companies globally and positioned well to capture the upside from this sector.

This is one sector I would be wary of, the global out looks to remain pessimistic for growth and this will continue to put downward pressure on commodities as inventories continue to rise.  You may see a lot more pain here before you are rewarded for your bravery.

Japan - Exporting Deflation?

It's been well publicised how the aggressive 'loose' monetary policy adopted by central banks is likely to be inflationary. The logic of this seems sound; they are printing trillions of dollars of money, and an increase in money supply should lead to inflation over the longer term.

Japan has recently undertaken extensive quantitative easing and has also directly attempted to depreciate their currency. One would presume this will cause inflation pressures; as mentioned above they have more money supply and also imports will become more expensive, thus importing inflation.

However, there is another take on this which I think is worth some consideration, and something I have not read too much about to date. Firstly we need to consider the Japanese economy. It is an export driven economy. Then we need to consider what a weaker Yen means for these exports. Well in essence it makes exports cheaper to foreigners who are importing them and this is the key to the deflationary pressures that Japan's latest policy could cause. So around the globe countries will be importing goods and services from Japan which are now cheaper, allowing businesses to lower prices and still maintain margins which could lead to deflation.

So what are the possible implications of this? Well the world has generally come to a consensus view that inflation could spike at some point due to the monetary stimulus mentioned above. However, if in fact Japan and other nations with weakening currencies are exporting deflation this may not be apparent, or at least to the extent markets are pricing in.

If you believe inflation may be 'overpriced' then one option is to 'short' inflation linked bonds whose returns are directly linked to inflation. Their price will fall if they have priced in too high inflation.

So for now lets hopefully look forward to some cheaper goods from Japan and be aware that high inflation is not yet a foregone conclusion!

Bad News Fails to Spook Investors

Equity markets edged higher today continuing a three day rally following on from a turbulent week.  There has been a substantial change in market behaviour since the start of 2013 as fear and volatility are becoming much more digestable. 

Equities have been the asset class of choice this year, as investors sought to take advantage of improving economic conditions mainly from the US.  After reaching record highs and rising almost 10% in the first three months, many investors have become cautious as this rise in equties has occurred very quickly given the level of corporate earnings and economic outlook.

We can expect equity markets to calm down somewhat as Q1 results begin to flow through, however what gives me cause for concern is the way news, especially bad news has been interpretted by markets. This year has already thrown a few curve balls at us.  Starting with Italy, their elections ended undecided leaving questions being asked about whether a governement can be formed to continue along the path agreed with the ECB and maintain their involvement with the Eurozone.  Whilst volatility spiked during this period, markets were remarkably unaffected.  There was an initial sell off on the Tuesday the results were annouced, however by the end of the week markets had closed higher.  Secondly, more Eurozone worries flowed through, this time from Cyprus as peripheral countries and their people were reminded how vulnerable they were as bank depositers faced haircuts.  This spooked the market again, having a slightly more significant effect than Italy, however yet again, over the following weeks, markets rallied back being pushed along by optimistic data out of the US.

More recent news surrounding North Korea, has been fairly localised.  South Korea has seen its markets and currency fall as a result, however global markets have been fairly reserved.

So why is bad news being taken so lightly?  This could be down to a number of reasons however it is evident that the psycological impact of bad news has been numbed over the past 5 years.  Since the credit crisis in 2008, we have seen consistent flow of bad news from Europe, then the Arab Spring, China's possible hard landing, US fiscal issues, the list goes on.  Investors have become used to this  and as a result markets can recover fairly quickly from the intial shock.  If the issues with Cyprus occured back in 2011, markets would have almost certainly reacted extremely to this. 

Another possible cause for markets to be bought back so quickly is the rotation into equity markets.  Many investors would have had a large exposure to fixed interest over the past 3 years, and now as bond yields reach record lows, there has been a rotation into equity markets (Great Rotation and the Hunt for Yield). This has certainly occured with the large amount of money sitting on the sidelines in cash.  As a result many investors see market pull backs as an opportunity to increase thier positions.  There is still a significant amount of money still on the fence, and this could continue to act as a support to markets throughout 2013.

A word of caution, when investors become complacent bad things tend to happen, so be wary of asset bubbles. 

In the meantime enjoy the ride, and if you are one of those investors still on the side line, climb aboard there is still plenty of opportunities out there.

Are UK Households the key to the Recovery?

As a nation the UK has a long history as a dynamic, skilled country and has historically had strong manufacturing and exports attracting business investment.

However, over the recent years the UK seems to have lost its edge. Our manufacturing sector has stalled and we are now a nation of 'importers' rather than 'exporters'. Business investment, particularly foreign investment has also slowed. These trends have escalated since the credit crunch and it is a troublesome path to be on. So in order for the recovery to really take hold we are going to need to see UK Households driving this, and picking up the slack left by flagging manufacturing and export sectors.

So the big question is 'are UK Households in a position to increase consumption?' Well since the credit crunch we have constantly read how consumers have been squeezed and disposable incomes have fallen - a bad sign if we want consumers to go out and spend spend spend! However, mortgage payments for many households have fallen, freeing up capital to spend. Previously consumers had taken on debt (credit cards, loans) in order to purchase goods and services. What we have seen over the past 5 years is households beginning to de-leverage, paying off their debts and increasing their saving rates. This is a good sign on two fronts; firstly consumers have less debt and so could likely increase their debt levels in order to make purchases. Secondly if households have large savings, they may consider spending this now as they will be earning very low interest by having it in the bank.

So there are mixed signs that the UK Households could increase spending in the economy. What I think we need to see is house prices increasing. This makes home owners feel more wealthy and will encourage them to spend in the economy, this has occurred over the past year in the US. Until this time households will continue to be cautious of their spending, and as such the UK economy will continue to exhibit low growth.

Property Funds - A useful portfolio diversifier

An asset class many people favour is property.  Be it owning properties personally or buying a property fund, it can provide an excellent return for your money.  There are a number of ways to access this market within an investment portfolio.

Lets classify this into three different types:

1. Bricks and Mortar Funds
2. Real Estate Investment Trusts (REITs)
3. Property Security Funds

Property is generally uncorrelated to most other asset classes however this can be dependant on which type of investment vehicle you choose.

Bricks and Mortar funds do what they say on the tin, the fund will invest and manage a number of properties directly. These will provide a low volatile fund generating both capital growth through the net asset value of the properties held and rental income.

The next type of investment is a REIT, this is a closed ended property investment trust, where an amount of money is raised and then a fund manager selects a portfolio of property. They are generally run in a very similar way to bricks and mortar funds however, because they are closed-ended, capital is not required to be kept uninvested (for redemptions) therefore these can capture more upside. REITs are however more volatile, as they are listed on the stock market and therefore be subject to supply and demand. Generally they will maintain a close price (discount) to its net asset vale.  Read more on REITs and Investment Trusts.

The final type is a property security fund, these are invested in securities, namely REITs and equities associated with property and these are generally the most profitable and volatile during property bull markets.

The first option will provide you with sturdy incremental gains where as the later two will be more volatile having the potential for greater upside. Each type of investment have their uses, and one would need to clarify why property is going to be added to the portfolio. If you see immediate upside from the property market, REITs and property security funds will be best, however if this is merely to act as a source of steady income and long term capital growth I would suggest the first option. 

Some interesting examples of each type of property fund are Ignis UK Property; a top quartile performing bricks and mortar fund with a focus on London and the South East commerical property.  First State Global Property Securities would be my first choice for a more volatile fund, it invests in a global selection of REITs and companies associated with property.  Finally REITs offer a more sector specific approach to property investment, an example of which would be Primary Health Properties plc, whereby it invests in healthcare focused properties such as GP practices.  Or British Land plc for a more diversified portfolio of properties.

Having looked at our poll about where you would have your money invested, almost 40% said property.  This is unsurpising, especially for our US readers as the property market there is much more buoyant.   Also areas in Asia have seen capital values rise signifcantly espcially in urban areas.  There is certainly a lot of positives within the global property market, however for the UK I am affraid it will stay somewhat subdued for the immediate term.

Pick your markets wisely and your funds even more so!

Infrastructure Investing

Here at Fundgurus we've discussed various investment themes and this latest article looks at Infrastructure as an investment theme.

'Infrastructure' is a broad term and I generally think of it encompassing areas such as utilities, transport (airports, railways, roads) and schools and hospitals. Infrastructure investment is something that is always required, whether it be to initially install the facility, or to improve or update existing infrastructure.

Often infrastructure is heavily supported by public spending and government policy. By investing in high-speed railways for example, governments can make their country more attractive to businesses and investment which helps support the economy. At the same time it creates jobs in the immediate term to actually build the infrastructure. With governments looking to stimulate economies there is a possibility we will see them target infrastructure directly, and we have actually seen the beginnings of this with Japan and U.S. policy.

Infrastructure can also provide an inflation-hedge. Real assets such as buildings have exhibited inflation protection in the past. Revenues, such as those from toll roads, are often linked to RPI and therefore also offer inflation protection.

For investors there are various funds and stocks available to invest in this infrastructure theme. HICL Infrastructure is a closed ended investment trusts (HICL) and has an attractive yield (c. 5.7%). First State Global Listed Infrastructure is an open ended fund investing in companies that are linked to the inflation theme. This provides a more global portfolio, but has tended to exhibit slightly more volatility then HICL.

This type of investment can produce steady returns making an attractive addition for portfolios for the long term investor.

Rising Costs and Wage Inflation

Rising costs globally have had detrimental effects on company profits and a fundamental cause of this has been wage inflation particularly in emerging markets.

As Asia contributes to a large proportion of global manufacturing, company profits are being squeezed as it becomes more costly to produce in these countries.  Costs have been further amplified by the rising currencies.  Emerging markets have seen their currencies rise as investors seek to capitalise on high GDP growth.

Asia has seen soaring wages and average pay has almost doubled over the past 10 years compared to 5% increase per annum in developed countries.  China led the way almost tripling over this period, and as the country develops from an emerging market, workers began to demand minimum wage levels.

This rising wage inflation is not isolated to Asia, South America has also seen similar rises, and as workers demand higher pay, their demands then mature for better consumer products, food and standard of living.  This is the common path from an emerging market country to a developed.  However there are many obstacles to overcome, read more on this in Rural Expansion and the Control of Urbanisation.  

For companies based in the US or other developed nations it may become more economical to bring manufacturing and production back to their country.  As wages become closer between the countries, after eradicating shipping costs, the difference is not that high.  With energy prices reducing in the US this is becoming more common, and reshoring may gather further pace.

Whilst wages have increased significantly, one must remember it started from a lower base, Asia is still a very cheap place to produce, and many have shifted from China, to South East Asian countries such as Indonesia, Vietnam and Thailand, where the minimum wage in Thailand is 300 Baht a day, a little over $10.

There will undoubtedly be a lot of change in emerging market economies over the next 10 years, however as a large proportion of growth is derived from manufacturing and production of goods for overseas companies, one must remember to maintain the competitive edge otherwise growth may evaporate.

Active vs Passive Investing

A common question people ask is, "What are better, active or passive investments?" Many investors see no reason paying the extra annual management charges if they do not feel actively managed funds out perform the index they are investing in.

Let's take North America as an example, I compared the S&P 500, (the top performing US index over the past 5 years) against its respective actively managed sector performance.  The S&P500 has returned 13.35%, whereas the IMA (Investment Management Association) North America Sector returned 53.5%. It is evident here that the actively managed funds have outperformed.  This is down to a number of reasons.

Firstly fund managers have the ability to pick the best equities out of the index leaving those which will under perform.  Secondly, and possibly the most important is that they are able to manage risk across the portfolio.  Selecting not only the best funds, but the best sectors, one is able to diversify risk across the fund.  Further analysis into the correlation of each equity held you can combine the weightings together to ensure optimum protection on the downside whilst being able to capture growth through stock selection.

The most common way of purchasing an index is through an Exchange Traded Fund (ETF), these are cheap ways of accessing a basket of companies.  There are usually two types of ETF, those that invest the money in the physical asset, in this case the constituents of the index, or those that swap performance of a basket of assets for that of the index.  The later is considered to be less desirable as many investors do not like holding something that isn't the asset they have paid for.  Never the less, these offer the closest replication of performance as there is very little tracking error (the difference between the actual index performance and the fund).  With the synthetic ETFs most offer a collateralised swap, worst case if the swap counter-party fails, you are usually guaranteed to receive AA rated bonds.

For long term investing over 20+ years many see it beneficial to hold just the index, it is a cheap and effective way to gain exposure to a country or market, it requires less research and in some cases will out perform managed funds.

However, for the best returns I would recommend actively managed funds, these will offer the best downside protection which would have been important over the past five years and if you select correctly the best returns.  Taking the earlier example of the US equity market, the S&P 500, recently hitting new highs has returned around 1303% since 1985.  Compare this to our North American equity fund in Top 10 Funds of the Month, Gorden Grender who runs GAM North American Growth has returned 2700%.  So which one would you rather have?

Actively managed funds need to be reviewed as there will undoubtedly be funds that under perform the index, so pick wisely.  

For those of you who are not convinced by this argument  a number of providers offer cheap access to equities and other asset classes via both ETFs and a handful of unit trusts.  Namely Vanguard, BlackRock's Ishares and Deutsche Bank's db X-Trackers